Trading AAPL Earnings today

Straddles and explosive Volatility

 

Apple ($AAPL) releases quarterly earnings after the closing bell today. Most traders intent on trading AAPL earnings rush to the Option series closest to the earnings event because the “uncertainty” around the earnings event marks up the premium of these Options. It is tempting to sell premium in this series because Implied Volatility is so high, and premiums are juicy. But there are perils with this approach – If in fact AAPL makes a very large move, premium sellers could face significant losses in this series. But there can be some very attractive opportunities if you move 1 series out in time. Lets take an example from today’s AAPL prices around 11 am.

 

 

 

Figure I above shows the different series with the Implied Volatility and the expected move as calculated by a 1-standard deviation move. The Oct4 Weeklys expire tomorrow. Look on the right hand side, it has an Implied Volatility of 92% with an expected move of + or – 32. Implied Volatility of 92% will certainly bid up Option prices, but you only have 1 day. And if AAPL moves more than 32, the positions you sold will get into trouble. A better opportunity lies right below that series in Nov1 weeklys expiring next Friday (8 days). Its Implied Volatility is 47%, the Nov monthly Implied Volatility is 40% and thereafter most series are 35 to 36%. So we can safely say that 35 to 36% is the steady state Implied Volatility as of today, and were it not for earnings being released today, all the Option series would be at this level. In fact, tomorrow morning, you’ll see that all Options series will be very close to 36% because the earnings event is over. So the Nov1 Weeklys can be expected to collapse from 47 to 36, which is a 11% point drop in Implied Volatility. And the best part is your risk exposure is minimal because you have time to react (next 7 days).

 

 

So a better way to play AAPL earnings would be sell a strangle in the Nov1 weeklys. You want to stay away from the series that’s expiring tomorrow, but go out 1 series. The risk profile of a strangle in the Nov1 series is shown below. You’re selling 1 contract at the 570 / 650 levels. You get a premium of $1100 on a margin of $8620. Your breakevens are at 560 and 662. As long as AAPL stays between these points, your strangle will be profitable. Notwithstanding, you can expect a drop of about 10 to 11% on Implied Volatility itself, so this by itself gives you a very big edge in the trade. Even if you keep the trade open until Monday, you should capture a return of 10% return in a few days, or a triple digit annual return if AAPL does not move close to the breakeven points. Also note that the breakeven points are outside of the 5% (red lines), they are more like 7 to 8%. Pretty safe trade ??

 

 

I’m putting this trade on today, and let’s see what happens. Will post an update tomorrow. If you have any comments or thoughts on this trade, please post them below in the comments section. Thanks for reading !

7 Comments

  • Jason

    Reply Reply October 26, 2012

    Hari, will you be posting the update here or on Linkedin ? Apple has missed its numbers, and i’m wondering about the impact on your trade.

  • Hari Swaminathan

    Reply Reply October 26, 2012

    Thx Jason – I will be posting a blog post on it. I’m waiting for the market to open so we can look at the Option prices. Yes $AAPL missed but its not suffering too badly in the pre-market. This trade should be a winner, I could potentially hold out till next Friday and capture 100% of the premium. by the way, I’ll post it to Linkedin also. Thx Hari

  • Hari Swaminathan

    Reply Reply October 26, 2012

    Hey Jason, have posted the results on my Blog as well as Linkedin. Check it out – this was a BLOCKBUSTER trade !!!

  • Jason

    Reply Reply October 28, 2012

    Awesome trade Hari, i saw it after market closed unfortunately

  • robby

    Reply Reply December 2, 2012

    Just saw the returns on its quite amazing and wanted to read your original basis for the trade. Nice work catching the Implied volatility. Question is will this always happen for all earnings

    • Hari Swaminathan

      Reply Reply December 6, 2012

      Robby it won’t happen every time. But it will happen more often than we expect it to. The trick is to search for these things. I track about 10 stocks during earnings reports to see if i see something out of place – if i do, then I move in for the kill. Like this one..

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